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The View from Abroad

As students of the Austrian School of Economics understand, financial bubbles are caused by central bank monetary policy and government intervention in the economy. The housing boom and subsequent crash in the first decade of this century is an excellent example of the Austrian Business Cycle Theory (the Austrian School’s explanation for booms and busts in the economy).

For more than 4 years between June of 2001 and September of 2005 the Federal Reserve kept its Federal Funds interest rate under 4 percent. Artificially low mortgage rates resulted. This coupled with large investments by the Bush Administration for low income homebuyers created the largest housing boom in American history. As interest rates were gradually increased by the Fed, reaching a decade high of 5.25 percent in June 2006, investments in housing that were made at lower interest rates became unsustainable at higher rates. As adjustable rate mortgage rates rose, defaults increased eventually causing home prices to plummet. The housing bubble had burst.

Of course, pundits, politicians, mainstream economists, and others dependent on big government for their sustenance blamed the free market and deregulation for the housing boom and bust. Yet, time and again in the Twentieth Century, from the stock market crash of 1929 to the dot com bubble of the late 1990s, the fingerprints of Fed manipulation and monetary price fixing have been all over every economic downturn and crisis.

Now, there are other bubbles in our economy that have yet to burst. These are the bubbles that are insulated from bursting by politics. They include higher education and defense spending.

In terms of defense spending, the political forces that protect it are currently working overtime to maintain that bubble. In January, under provisions of the Budget Control Act of 2011, defense budget cuts totaling about $50 billion a year for the next 10 years go into effect. Opponents of the cuts, like Senator Lindsey Graham are claiming “It would be like shooting yourself in the head. It would be the most destructive thing in the world.” John McCain has even warned that the cuts would leave us unable to defend the country!

Then there are the threats of wide spread layoffs by defense contractors and the devastation to local communities like Newport News, Virginia that defense budget cuts would bring. Corporate officials and community leaders have teamed up to decry the cuts based solely on the harm they would do to their bottom lines and tax bases without any regard for whether as a nation we should spend the money on more armaments.

After all, defense spending accounts for close to 20 percent of all federal spending. The U.S. spends more on defense than the next 13 highest spending countries combined!

This enormous government bubble has been financed for years by deficit federal spending monetized by the Federal Reserve – in other words debt. Since at least Reagan, military spending has been erroneously used as a fiscal stimulus to the economy, financing millions of jobs in the military-industrial complex. And it has been used to launch several seemingly endless wars and other lethal adventures worldwide.

The country doesn’t need that much military and can no longer afford it. As the real fiscal cliff approaches, political defenders of the military-industrial complex are going to find it more and more difficult to protect their bubble. With hundreds of trillion of dollars in future unfunded liabilities on the books of the federal government, the only answer for Washington is to continue to print more money. Eventually interest rates will rise increasing the interest payments on the debt. More printing will occur perpetuating a financial spiral which will destroy what’s left of our economic system. Cutting a measly $50 billion a year from military spending now should be a no-brainer. But it probably won’t happen because anymore politics takes precedence over reason in Washington.

Kenn Jacobine teaches internationally and maintains a summer residence in North Carolina

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